Liberty Matters

Ideas Mattered, But So Did Institutions


Don Boudreaux wisely rejects the idea that ideas did not matter. Where did we ever get that idea? One answer, of course, is from Marx and his sidekick Friedrich Engels, whose (a)historical materialism was as doctrinaire as it was mistaken. But modern economists are not necessarily much better. In their widely reviewed and noted massive Why Nations Fail, noted economists Acemoglu and Robinson have no interest in “culture” (which is a close cousin of “ideas”). On the other hand, Professor  McCloskey, with equal certainty, rejects the notion that “institutions” mattered. England had a rule of law and property rights in the Middle Ages, she says, and so how can institutions explain the Industrial Revolution of the late 18th century? So: ideas, yes, but institutions, no. Professor Boudreaux is convinced.
Not so fast. If by “institutions” we mean formal institutions that regulate the relation between King and subject, between taxer and taxpayer, perhaps so. But that is an overly narrow definition of the classic Northian view of what institutions do and what they are. Institutions are the rules by which the economic game is played. Certain actions are rewarded, others are punished. They thus form a huge matrix of incentives that help determine how everyone plays the game. One set of rules determine whether taxes are levied reasonably and whether the King respects his subjects’ property and other legal rights. But there is so much more. And by dismissing the Northian definition, McCloskey and Boudreaux are rash in dismissing the importance of the rules of the economic game for subsequent economic development in Britain.[7]
The short answer to why Britain was so successful can be summarized in two words: attitudes and aptitudes. Professors McCloskey and Boudreaux make a convincing case for attitudes. The case they make is incomplete (whose attitudes exactly, and how about minor intellectual developments preceding the Industrial Revolution such as the Enlightenment — arguably the most significant intellectual development in the Western World since monotheism?), but it is convincing. Attitudes matter. But what about aptitudes? Can we understand them without worrying about institutions?
One such institution is apprenticeship. Mechanical skills and ingenuity, like playing music, required both a born talent and training. Talents may be distributed uniformly across nations (though malnutrition and disease could cause irreversible damage to them), but training required something more. Before the Industrial Revolution there were no technical high schools or community colleges. An artisan was trained by another. Masters begot apprentices. Apprentices became masters and trained more. Cultural evolution in action.  Every skilled craftsman produced two things: a product or service and young men trained to make more. Cultural evolution in action.
A moment’s reflection will indicate that, to work well, apprenticeship needed an institutional framework in which it could function. After all, the contract written between a Master and an Apprentice (usually the parents) was the Mother of all Incomplete Contracts. In it both sides agreed on a complex bilateral deal that contained multiple components: training as well as room and board for the apprentice, a cash payment, and the promise of future services for the Master. It is literally impossible to specify fully the contract between them, since such a contract cannot contain all the details of the skills that the Master will teach the eager young pupil, or the various chores and services the Apprentice will carry out in return. Since the relation was a one-shot encounter, a naive economist might think that both sides would behave opportunistically. Such behavior did occur, inevitably. In truly egregious cases, of course, one of the parties could go to court, but given the slowness, high cost, and unpredictable nature of court decisions, this was truly a pis aller. Another way of enforcing and overseeing this contract was through craft guilds, which in some Continental regions regulated the entire training process. Both of these options could be found to some extent in England before the Industrial Revolution.
But it is clear that apprentice contracts, to work well, needed something more, and that was spontaneous, self-enforcing contracts.[8] Many writers on institutions, above all Avner Greif, have emphasized the importance of reputation effects in making “private-order” institutions work.[9] In the small artisanal communities of England’s provincial towns people knew one another. Opportunistic or immoral behavior toward one’s apprentices would be punished, not only by drying up the supply of would-be youngsters, but through a bad reputation that could spill over to creditors, customers, suppliers, and so on. For the youngster, too, there were reputational considerations, not just concerning him but his family as well. Guilds, on the other hand, especially outside London, had lost their regulatory power.
That this training system worked astonishingly well in Britain is supported by the Continent-wide reputation that British artisans had for high-skills. One Swiss visitor said in 1766 that for a thing to be perfect, it has to be invented in France and worked out in England. Between 1750 and 1850, tens of thousands of English and Scottish engineers and mechanics swarmed to the Continent to install, maintain, and operate machinery. John  Kennedy, a Manchester cotton manufacturer, stated the obvious in 1824: that it was impossible to use machinery “without having at hand people competent to its repair and management.” But the manufacture of competence itself required institutions that made training contracts work, and hence institutions were important.
In other areas, too, the story cannot be told without institutions. Think of corruption: it is all good and well to have a judiciary and a tax administration that have formal limitations (the much-loved “constraints-on-the-executive” of the institutional literature), but how corrupt is it? Recent work on China shows how the Imperial administration, on the surface a well-working machine, was destroyed internally by local corrupt officials.[10] In today’s world, corruption is widely seen as the central obstacle to economic progress in nations as far apart as Nigeria, Pakistan, and Russia. It weakens the judiciary, unravels contracts and property, distorts the allocation of property, misdirects incentives and efforts, reduces the efficacy of the public sector in creating infrastructure, and in the end can threaten to extinguish the spirit of enterprise and risk-taking needed for technological progress and commercial development.  Corruption is one area in which the world of ideology and beliefs feeds directly into the institutional framework and from there to economic development. If the ruling ideology is that corruption is morally unacceptable and if people who believe so know that this belief is widely shared, there will be little corruption (think: the Netherlands).
In 1700, Britain was still thoroughly corrupt: political favors were bought and sold, and people in power handed out patronage to their relatives and friends, and enriched themselves in sometimes shameless ways. Mercantilism was, among others, a system of rent-seeking, designed to extract resources from those with little political influence for the benefit of an elite in power.[11] After 1750, corruption in Britain went on the decline. Under the influence of Enlightenment ideas, corrupt practices came under fire in the late 18th century. Radical critics raised questions of corruption and privilege at the expense of the well-being of the realm, and the ruling elite, whether under pressure from such critics, or because they themselves had been influenced by enlightened thought, reformed government.[12] By 1830, the Duke of Wellington complained that as prime minister he had no patronage to hand out. There remained a few bad apples, but the post-1830 Whig reforms effectively disposed of those as well.
Corruption is the institutional dog that did not bark. It is perfectly reasonable to think of a hypothetical world in which predatory rent-seeking by a powerful elite could have expropriated the profits of innovative entrepreneurs in the Industrial Revolution, as was traditionally done in the medieval world. Instead, the British aristocrats who ruled the country in the 18th century let the entrepreneurs have their way and pocketed the capital gains on their real estate holdings and the interest on their railway bonds. Organizations such as the rent-seeking monopolies, set up in the age of mercantilism (think of the East India Company or the Bank of England), were either dismantled or turned into public institutions. Slowly but certainly rent-seeking institutions were weakened. By 1850 or so the country was as free of it as any nation had the right to hope for.
How then to think of the “ideas vs. institutions” debate? Oddly enough McCloskey and Acemoglu-Robinson both seem committed to a “one-or-the-other” mode. But it is not so. Institutions rest on beliefs. If we have rules against the sale of narcotics, it is because someone in power believes that such drugs are socially bad. When those beliefs change, the institutions (hopefully) adapt. Adaptiveness requires meta-institutions that can change the rules when beliefs and/or circumstances change. Britain’s great success between 1750 and 1914 rested on the existence of such meta-institutions. When needed, Parliament set up a committee that researched and investigated matters ad nauseam and then changed the rules. Slowly, and perhaps not always quite perfectly, British formal institutions adapted. But the same was true for private-order institutions: the rather sudden rise of country banks in the second half of the 18th century illustrates the high degree of  adaptiveness of private-order British institutions; they were not coordinated or supervised by some central authority, and no political revolution was necessary to bring them into existence. Yet once the circumstances were suitable and opportunities arose, these banks emerged almost ab nihilo. They replaced the informal activities of local merchants, notaries, and attorneys who had previously intermediated in credit transactions.
Ideas mattered, but so did institutions. Their continuous interaction and coevolution in Europe from 1500 created Modern Science, the Industrial Revolution, and McCloskey’s “factor of fifteen or more” by which income grew — and living standards by a lot more. How they did interact precisely remains one of the great challenges of historical social science. The greatest idea of them all, underemphasized by her, is the somewhat fuzzy and inconsistent set of beliefs we still call the Enlightenment. Without the ideas of Enlightenment philosophers, the growth-enhancing institutions established in the young American Republic are unthinkable. Where the Enlightenment  came from and what it did to the economy should remain at the center of our agenda. Defending it against the cantankerous “critical theorists” who see the Enlightenment as a conspiracy of an 18th century white male imperialist elite remains of paramount importance.[13]
[7.] Some of the following is based on Joel Mokyr, “The Institutional Origins of the Industrial Revolution.” In Elhanan Helpman, ed., Institutions and Economic Performance (Cambridge, Mass.: Harvard University Press, 2008), pp. 64–119.
[8.] Jane Humphries, “English Apprenticeships: A Neglected Factor in the first Industrial Revolution.” In Paul A. David and Mark Thomas, eds., The Economic Future in Historical Perspective (Oxford: Oxford University Press, 2003), pp. 73–102.
[9.] Avner Greif, Institutions and the Path to the Modern Economy: Lessons from Medieval Trade (Cambridge: Cambridge University Press, 2005).
[10.] Tuan-Hwee Sng, “Size and Dynastic Decline: The Principal-Agent Problem in Late Imperial China 1700-1850.” Explorations in Economic History (in press, 2014).
[11.] Robert B. Ekelund Jr. and Robert D. Tollison, Mercantilism as a Rent-Seeking Society (College Station: Texas A&M University Press,1981).
[12.]See especially Philip Harling, The Waning of ‘Old Corruption’: The Politics of Economical Reform in Britain, 1779–1846 (Oxford: Clarendon Press, 1996).
[13.] Max Horkheimer and Theodor W. Adorno, Dialectic of Enlightenment, ed. by Gunzelin Schmid Noerr (Stanford, Calif.: Stanford University Press, [1947] 2002).